Free trade: pros and cons

Table of contents: The Kazakh-American Free University Academic Journal №2 - 2011

Author: Mantel Renata, Kazakh-American Free University, Kazakhstan

For several centuries free trade has always been viewed as the best trade policy among countries. Blinder [1992] states that despite this intellectual barrage, many “practical” men and women continued to view the case for free trade sceptically, as an abstract argument made by ivory tower economists with, at most, one foot on terra firma. This point of view was based upon the convincement that industries had to be protected from foreign competition. Blinder [1992] says that the divergence between economists’ beliefs and those of men and women on the street seems to arise in making the leap from individuals to nations. In running our personal affairs, virtually all of us exploit the advantages of free trade and comparative advantage without thinking twice.

The value of free trade was first observed and documented by Adam Smith. In 1776 he wrote in his “The Wealth of Nations”: “If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage”. Free trade is a system in which goods, capital, and labour flow freely between nations, without barriers which could hinder the trade process. Many nations have free trade agreements, and several international organizations promote free trade between their members. There are a number of arguments both for and against this practice, from a range of economists, politicians, industries, and social scientists [Smith undated]. The most important general trade agreement is the General Agreement on Tariffs and Trade (GATT) signed in October 1947 to liberalize trade, to create an organization to administer more liberal trade agreements, and to establish a mechanism for resolving trade disputes. The most significant free trade zones are the European Union (EU), the North American Free Trade Agreement (NAFTA), and the Association of Southeast Asian Nations (ASEAN). World Trade Organization (WTO) is a global organization for regulating trade agreements, trade negotiations and resolving trade disputes.

So what is free trade? It is supported by most economists. What are its pros and cons? What arguments are there in favour of free trade? What arguments are there to support the contrary? Let us have a more precise look at the matter.

Free trade: general notion

Smith [undated] defines free trade as a system in which goods, capital, and labour flow freely between nations, without barriers which could hinder the trade process. Many nations have free trade agreements, and several international organizations promote free trade among their members. There are a number of arguments both for and against this practice, from a range of economists, politicians, industries, and social scientists. Krugman and Obstfeld [2009] say restrictions on the flow of currency are also lifted, as are regulations which could be considered a barrier to free trade. Put simply, free trade enables foreign companies to trade just as efficiently, easily, and effectively as domestic producers. Free trade as a positive economic effect was first marked by Adam Smith in “The Wealth of Nations” in 1776. Another economist, David Ricardo, studied the matter of free trade and its benefits by presenting a specialized economic proof featuring a single factor of production with constant productivity of labour in two goods, but with relative productivity between the goods different across two countries. Krugman and Obstfeld [2009] give a good notion of the Ricardian model that demonstrated the benefits of trading via specialization - states could acquire more than their labour alone would permit them to produce which formed then one of the fundamental laws of economics: The Law of Comparative Advantage. Under a policy of free trade, trade via specialization maximizes labour, wealth and quantity of goods produce, exceeding what an equal number of autarkic states could produce. As mentioned by Krugman and Obstfeld [2009] under a free trade policy, prices are a reflection of true supply and demand, and are the sole determinant of resource allocation. The authors [Krugman, Obstfeld 2009] report that interventions include subsidies, taxes and tariffs, non-tariff barriers, such as regulatory legislation and quotas, and even inter-government managed trade agreements such as the North American Free Trade Agreement (NAFTA) and Central America Free Trade Agreement (CAFTA) and any governmental market intervention resulting in artificial prices.

Many classical liberals, especially in Britain in the 19th and early 20th century (e.g. John Stuart Mill) and in the United States in the 20th century (e.g. Cordell Hull), believed that free trade promoted peace. All economists agree on the point that free trade possesses the following features: possibility of no-tax trade of goods (including tariffs), quotas on imports, etc; no-tax trade in services; absence of taxes, subsidies, regulations, or laws that give some factors of production an advantage over others; free access to market and market information; free movement of labour and capital between and within countries. At the same time there is a large matter for debate.

Arguments in favour of free trade

The first set of pro-arguments is essentially economic, that free trade will make society more prosperous by increasing the global level of output through specialization. Specialization allows nations to devote their scarce resources to the production of the particular goods and services for which that nation has a comparative advantage, and subsequently increase the global production possibility frontier. The other set of arguments for free trade could be classified as "moral" arguments based on the right of every person to exchange freely the result of his labour for the productions of other people. Many economists suppose that increased free trade is the best way to overcome extreme poverty in the world and enhance national security. The Economics Help Website [2010] reports that theory of comparative advantage explains that by specialising in goods where countries have a lower opportunity cost, there can be an increase in economic welfare for all countries. Being an engine of growth free trade also increases such spheres as export and competition and makes use of surplus raw materials.

For example, Middle Eastern counties such as Qatar are very rich in reserves of oil but without trade there would be not much benefit in having so much oil. Japan on the other hand has very few raw materials without trade it would be very poor [Economics Help Website 2010]. Besides it gives third-world farmers an opportunity for an actual life, having a fairly-paid wage for their job promoting good farming, as a lot of fair-trade produce is also organic. Specialization generates the highest level of production of the two goods. Then, through trade, each nation can consume the amount of the good that it wants to consume. In this way, production is maximized because each nation is doing what it does most efficiently. The benefits of economies of scale will ultimately lead to lower prices for consumers. In 2001, during the height of free market protests and support, the “Economist” journal argued in favour of free markets by looking at some of the points from whom they call “anti-globalists”: developed countries grow rich by selling capital-intensive products for a high price and buying labour-intensive products for a low price. This imbalance of trade expands the gap between rich and poor. The wealthy sell products to be consumed, not tools to produce. This maintains the monopolization of the tools of production, and assures a continued market for the product. Thus a multiplier effect of their money would be created as it circulates around their economy, and wealth in the poor country would be created more rapidly. Free trade and free markets are essentially about making trade easier by allowing the market to balance needs, supply and demand. Within a nation, it can be a positive engine for development. Though, the current system in its reality is hardly the free trade that the theories describe.

Arguments against of free trade

It is common to hear of today’s world economic system as being “free trade” or “globalization”. Socialists frequently oppose free trade on the ground that it allows maximum exploitation of workers by capital. To those who oppose socialism, this becomes an argument against free trade. According to Shah [2006] such ideas as markets being self-balancing to meet supply and demand, while increasing prosperity for those who participate freely sounds very appealing, in theory. However there are increasing concerns that go to the heart of the system itself such as: What about the reality of the current form of globalization, compared to the theory? How has it affected various segments of society around the world? What has been the impact on the environment? Is it even free trade? Shah [2006] underlines, these types of concerns had a consequence of criticisms of the current form of globalization, and given a bad name to “free trade” and “free market capitalism” in various circles.

Smith [2003, pp. 4-5] expresses concern, so long as weak nations could be forced to accept the unequal trades of Adam Smith free trade, they would be handing their wealth to the imperial-centres-of-capital of their own free will. In short, Adam Smith free trade, as established by neo-mercantilists, was only mercantilism hiding under the cover of free trade. Nowadays everything is more complicated too. We have, for example, products being exported from the poorer countries. However, with labour being paid less than their fair wages in the poorer nations, wealth is still accumulated by the richer nations. While it might appear that free trade is taking place, the wealth that is accumulated by the richer countries suggests this is still the age-old mercantilism process being played over again; a system that Adam Smith criticized so much [Shah 2006].

Economic arguments against free trade criticize the assumptions or conclusions of economic theories saying that free trade benefits only the wealthy within countries. Within the free trade sphere companies produce goods in less-developed countries where environmental and labour standards imposed are lower. According to Bunzl [1999, pp. 17 – 21] it is far from some altruistic motive to see those in poor countries improve their lot and thus narrow the gap between rich and poor, globalisation therefore merely serves as an efficient, low-cost method for TNCs to take advantage of low taxes, weak regulations and vulnerable labour whilst penetrating the economies of developing countries. Another disadvantage of produced by free trade is eliminating of traditional ways of living and rural cultures. There is also the Infant Industry Argument suggested on the Economics Help Website [2010]: if developing countries have industries that are relatively new, then at the moment these industries would struggle against international competition. Another argument is that of the senile industry: if industries are declining and inefficient they may require large investment to make them efficient again. Protection for these industries would act as an incentive to for firms to invest and reinvent themselves.

Free-traders contend that exports foster economic growth. If it is valid, then growth in world trade should correspond with growth in world GDP. But if we take recent period when world trade was increasing at a rapid rate and for which statistics are available: 1990 – 1998, we see that while trade increased world GDP grew very slowly (see Figure 1 Growth Rates – World Data).

Figure 1 Growth Rates – World Data (WTO)

Therefore free trade development does not make any significant influence on the GDP growth. The global financial crisis, brewing for a while, really started to show its effects in the middle of 2007 and into 2008. A number of countries have spoken out against the WTO saying that there needs to be more co-operation between the North and South (a general term to refer to the Rich and Developing countries, respectively) with regards to international trade. All these reasons build up a serious argument against the free trade policy.

Net benefits of free trade

In my opinion most free traders would agree that although increasing returns to scale might mean that certain industry could in settle in a geographical area without any strong economic reason derived from comparative advantage, this is not a reason to argue against free trade because the absolute level of output enjoyed by both "winner" and "loser" will increase with the "winner" gaining more than the "loser" but both gaining more than before in an absolute level. Krugman [2008] suggests that protectionism may be necessary for a while as these are not normal conditions where the case for protectionism may be on weaker grounds, at least for industrialized nations. Some economists criticize the WTO's definition of "free trade" as too narrow. Free trade implies specialized industries and economic change that can lead to strains and considerable changes to traditional economic and political systems and, according to Friedman [1999, p. 240], an analysis comparable to the risk-return spectrum of free trade with respect to both country and careers is an area in need of further research. According to the U.S. International Trade Commission, for example, the U.S. gain from removing trade restrictions on textiles and apparel would have been almost twelve billion dollars in 2002 alone. This is a net economic gain after deducting the losses to firms and workers in the domestic industry. The best possible outcome of trade negotiations is a multilateral agreement that includes all major trading countries allowing many participants to achieve the greatest possible gains from trade. After World War II, the United States helped found the General Agreement on Tariffs and Trade (GATT), which quickly became the world’s most important multilateral trade arrangement. Another example is the annual gain from removal of tariff and non-tariff barriers to trade as a result of the Uruguay Round Agreement (negotiated under the auspices of the GATT between 1986 and 1993) that was put at about $96 billion, or 0.4 percent of world GDP [Irwin 2008].

Gains from trade in economics refer to net benefits to agents from voluntary trading with each other. As for the Republic of Kazakhstan, free trade proved itself as an efficient economic model. Kazakhstan is a member of the Single Economic Space, signed on September 19th, 2003 during a CIS Summit in Yalta. On 15 April 1994 in Moscow an agreement was signed to create a free trade area between Azerbaijan, Armenia, Belarus, Georgia, Moldova, Kazakhstan, the Russian Federation, Ukraine, Uzbekistan, Tajikistan and the Kyrgyz Republic confirming their adherence to free development of a mutual economic cooperation. Besides Kazakhstan signed such cooperation agreements on free as: Agreement on Foundation of Eurasian Economic Community; Agreement on Free Trade between the Government of Georgia and the Government of the Republic of Kazakhstan, etc. Ministerial statement was agreed between New Zealand, Russia and its Customs Union partners Belarus and Kazakhstan to commence negotiations on a comprehensive and modern Free Trade Agreement (FTA), and to complete these negotiations by the end of 2011 [New Zealand Ministry of Foreign Affairs and Trade Website 2010]. Some experts fear that such free trade zones could hurt some investment projects. But an important advantage is the creation of the common juridical basis, license rules and non-tariff regulations that provides an easier process of movements of goods removing trade barriers. GDP growth of 6% is projected for 2011-2015 in Kazakhstan, and much is expected from the free trade agreements.

Free trade is one of the most debated topics in economics of the 19th, 20th, and 21st century. Arguments over free trade can be divided into economic, moral, and socio-political arguments. Friedman [1999, p. 240] states, the academic debate among economists is currently settled in favour of free trade, with a consensus having existed since at least the 1960s, based on theories dating to the 18th century. The idea behind free trade is that it will lower prices for goods and services by promoting competition. Domestic producers will no longer be able to rely on government subsidies and other forms of assistance, including quotas which essentially force citizens to buy from domestic producers, while foreign companies can make inroads on new markets when barriers to trade are lifted. In addition to reducing prices, free trade is also supposed to encourage innovation, since competition between companies sparks a need to come up with innovative products and solutions to capture market share. Free trade can also foster international cooperation, by encouraging nations to freely exchange goods and citizens. In free market economies, for example, people are expected to move to where jobs can be found, and to adjust their work lives and cultural tastes to the demands of a global market [Alexander 2001]. Agreements between trading partners can also promote educational advantages, such as sending engineers to train with people in the top of the engineering field in one nation, or sending agriculture experts to rural areas to teach people about new farming techniques and food safety practices.

Free trade implies specialized industries and economic change that can lead to strains and considerable changes to traditional economic and political systems. There is no doubt that the world is becoming more and more globalized, and the process is going on very quickly, with free trade being one of its features. Today, most arguments against free international trade are raised by special interest groups. When speaking about globalization issues Shah [2006] supposes that the interests of powerful nations and corporations are shaping the terms of world trade. In democratic countries, they are shaping and affecting the ability of elected leaders to make decisions in the interests of their people.


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Table of contents: The Kazakh-American Free University Academic Journal №2 - 2011

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